Polly Wilkins and Lara Levinson, London-based lawyers for global disputes and investigations law firm Kobre & Kim, unpack the myriad of legal and financial risks associated with the explosive rise in NFT sales
The art world is collectively on the up slope of a steep learning curve about Non-Fungible Tokens (NFTs) – unique, cryptographically secured digital assets which have been growing increasingly popular since the beginning of 2021. These assets include high-value artworks and digital collectibles purchased by high-net-worth investors. Like traditional artworks, NFTs are particularly susceptible to fraud and raise risks that artists, sellers, and buyers should consider with appropriate legal advice.
(Top of page – Beeple (Mike Winkelmann)’s MF Collection, sold as an NFT for $777,777.77 in 2020)
With the recent media spotlight on NFTs, anyone involved in art transactions could find themselves embroiled in a government action related to an NFT or an NFT sale. Counsel can assist stakeholders involved in these transactions – be it artists, galleries, auction houses, or high-net-worth investors – in protecting themselves, their assets, and their reputations should they find themselves exposed to either fraud or aggressive government action.
Risks for private collectors and art institutions
Although exciting, investing in NFTs raises various risks art market participants should consider among the aesthetic and financial aspects of a transaction. Some of these risks are familiar to the art market, and some are peculiar to digital assets or amped up due to the current interest.
For instance, an NFT investor, like any other art investor, could be the victim of a fraudulent seller attempting to transfer a work or rights in a work that they do not own. Potentially more worrisome, government authorities may take an interest in a sale. Authorities in the United States, United Kingdom or elsewhere may believe that an NFT was purchased with the proceeds of criminal activity or was used for money laundering.
These concerns have prompted the United Kingdom to require all art market participants to register with the tax authorities for money laundering supervision. Government authorities separately could suspect that a seller is attempting to manipulate an NFT’s value through fraudulent trades.
In any of these scenarios, authorities may try to disrupt sales, seize works, or bring criminal charges. These types of actions could be taken anywhere in the world, due to the nature of crypto-assets and blockchain registration, and impact any market participants.
Protecting yourself and your assets
Individual investors and family offices aiming to gain exposure to the digital assets market should consider obtaining legal counsel who can anticipate these risks and act if there is a private dispute or if the government comes calling. At the outset of a transaction, legal counsel can conduct due diligence through forensic analysis tools.
A law firm, particularly with in-house blockchain forensics capabilities, could prepare an analysis to show the legitimate source of purchase funds by reviewing the traditional funds or cryptocurrency intended for the sale. Legal counsel can then deploy these analyses if the buyer and seller relationship turns acrimonious, or if a government authority gets involved.
For example, if you are an NFT purchaser who has been swept up in fraud-type claims, counsel could prepare the analysis for submission and discussion with government enforcement agencies demonstrating that the purchaser complied with any applicable anti-money laundering regulations. In addition, if an NFT purchaser is accused of fraudulent claims such as (but not limited to) market manipulation, counsel could assist with responding to information requests from government agencies and develop counterarguments supporting that the underlying purchasing activity is indeed lawful.
Experienced counsel can also consider various strategies to attempt to protect digital and other assets in the face of government action. This may mean aggressively challenging the government’s actions, including challenging which government even has the authority to pursue suspected fraud based on the diffuse nature of crypto-assets. Additionally, it could mean working cooperatively with the government to assist with investigations against the fraudsters.
Protecting your reputation
A private dispute or government action often brings forth unwanted attention and potential damage to one’s public reputation. As such, any seller or purchaser caught up in a dispute or government enforcement action needs to consider not only the risk of reputational damage, but also how to preemptively mitigate its related damages (particularly to one’s ongoing commercial efforts, such as unrelated investments).
These risks may range from lawsuits over reputational harm to unforgiving news outlets eager to report on transactions by high-net-worth or celebrity investors and artists. Experienced counsel can coordinate a team of legal, crisis communications and public relations professionals to tackle these challenges.
The Future for NFTs
With art moving further into the digital realm, as well as the blending of traditional art houses and laws with new digitally native modes of producing high-value art pieces and other digital collectibles, comes both investment opportunities and risks. Both the potential upside and the downside have equally important implications for individuals who engage with the NFT ecosystem. Ultimately, NFTs present another iteration of creative expression that has begun to significantly change the art world. How private disputes and government enforcement actions develop – and how both traditional investors and art houses respond – will set an important precedent for investors in the digital art economy.